New Economics Papers
on Banking
Issue of 2010‒12‒04
24 papers chosen by
Christian Calmès, Université du Québec en Outaouais

  1. Case Study of Three German Banks Stuck in the Subprime Crisis By Peixin Zhang
  2. The effect of the interbank network structure on contagion and financial stability By Co-Pierre Georg
  3. Financial Contagion through Bank Deleveraging: Stylized Facts and Simulations Applied to the Financial Crisis By Thierry Tressel
  4. The Last Major Irish Bank Failure: Lessons for Today? By Cormac Ó Gráda
  5. Bankers Without Borders? Implications of Ring-Fencing for European Cross-Border Banks By Anna Ilyina; Eugenio Cerutti; Yulia Makarova; Christian Schmieder
  6. Does a banking relationship help a firm on the syndicated loans market in a time of financial crisis? By Herve Alexandre; Karima Bouaiss; Catherine Refait-Alexandre
  7. Understanding Liquidity and Credit Risks in the Financial Crisis By Deborah Gefang; Gary Koop; Simon M. Potter
  8. Information sharing and information acquisition in credit markets By Artashes Karapetyan; Bogdan Stacescu
  9. Thailand’s Commercial Banks’ Role in Financing Dams in Laos and the Case for Sustainable Banking By Carl Middleton
  10. A New Index of Currency Mismatch and Systemic Risk By Romain Ranciere; Aaron Tornell; Athanasios Vamvakidis
  11. The adverse feedback loop and the effects of risk in both the real and financial sectors By Scott Davis
  12. Bank efficiency and openness in Africa: do income levels matter? By Simplice A, Asongu
  13. Contestability and collateral in credit markets with adverse selection By Cesaroni, Giovanni
  14. Too Big to Innovate? Scale (dis)economies and the Competition-Innovation Relationship in U.S. Banking By Bos Jaap; Lamoen Ryan van; Economidou Claire
  15. The Community Reinvestment Act and small business lending in low- and moderate-income neighborhoods during the financial crisis By Elizabeth Laderman; Carolina Reid
  16. A Diamond-Dybvig Model Without Bank Run: the Power of Signaling By Kiss, Hubert Janos
  17. Risky Mortgages in a DSGE Model By Chiara Forlati; Luisa Lambertini
  18. How to evaluate an Early Warning System? Towards a United Statistical Framework for Assessing Financial Crises Forecasting Methods By Candelon Bertrand; Dumitrescu Elena-Ivona; Hurlin Christophe
  19. Seven Pillars of Wisdom By Giovanni Barone-Adesi
  20. Diversion of loan use: who diverts and why? By Khaleque, Abdul
  21. Why crises happen - nonstationary macroeconomics By Davidson, James; Meenagh, David; Minford, Patrick; Wickens, Michael
  22. Are all Credit Default Swap databases equal? By Sergio Mayordomo; Juan Ignacio Peña Sánchez de Rivera; Eduardo S. Schwartz
  23. Perfect surcharging and the tourist test interchange fee By Zenger, Hans
  24. Government Intervention and the CDS Market: A Look at the Market’s Response to Policy Announcements During the 2007-2009 Financial Crisis By Caitlin Ann Greatrex; Erick W. Rengifo

  1. By: Peixin Zhang
    Abstract: This paper is aimed at finding banks' destabilizing behaviors that explain why the impact of the crisis is so serious in the banking system. By comparing three German banks stuck in the crisis, I find that: I) the leverage is a common destabilizing factor and, ii) the banks were highly interconnected to other financial institutions and had a large maturity mismatch were more seriously affected by the crisis.
    Keywords: Systemic crisis, Leverage, Maturity mismatch, Banking regulation
    JEL: G14 G21 G28
    Date: 2010
  2. By: Co-Pierre Georg (School of Economics and Business Administration, Friedrich-Schiller-University Jena)
    Abstract: In the wake of the financial crisis it has become clear that there is a need for macroprudential oversight in addition to the existing microprudential banking supervision. One of the lessons from the crisis is that the network structure of the banking system has to be taken into account to assess systemic risk. There exists, however, no analysis on the influence of the network topology on contagion in financial networks. This paper therefore compares contagion in Barabási-Albert (scale-free) with Watts-Strogatz (small-world) and random networks. A network model of banks, a firm- and household-sector as well as a central bank is used. Banks optimize a portfolio of risky investments and risk-free excess reserves according to their risk and liquidity preferences. They form a network via interbank loans and face a stochastic supply of household deposits. Contagion effects from the default of a large bank are studied in different network topologies. The results indicate that contagion is more severe in random and scale-free networks than in small-world networks. This situation changes when the central bank is not active in which case small-world networks are less stable than scale-free and random networks. It is also shown that interbank liquidity above a certain threshold leads to endogenous instability, regardless of the network topology. The results further indicate that network heterogeneity does not contribute to financial instability.
    Keywords: systemic risk, contagion, interbank markets, network models
    JEL: C63 E52 E58 G21
    Date: 2010–10–05
  3. By: Thierry Tressel
    Abstract: The financial crisis has highlighted the importance of various channels of financial contagion across countries. This paper first presents stylized facts of international banking activities during the crisis. It then describes a simple model of financial contagion based on bank balance sheet identities and behavioral assumptions of deleveraging. Cascade effects can be triggered by bank losses or contractions of interbank lending activities. As a result of shocks on assets or on liabilities of banks, a global deleveraging of international banking activities can occur. Simple simulations are presented to illustrate the use of the model and the relative importance of contagion channels, relying on bank losses of advanced countries’ banking systems during the financial crisis to calibrate the shock. The outcome of the simulations is compared with the deleveraging observed during the crisis suggesting that leverage is a major determinant of financial contagion.
    Keywords: Banks , Cross country analysis , Economic models , External shocks , Global Financial Crisis 2008-2009 , Globalization , International banking ,
    Date: 2010–10–19
  4. By: Cormac Ó Gráda (University College Dublin)
    Abstract: This paper describes Ireland last major bank failure before the collapse of Anglo-Irish Bank in 2008. It points to resonances between that earlier failure and the events that led to the downfall of Ireland's banking system in 2008-2010.
    Keywords: banking, Ireland, moral hazard, crony capitalism
    Date: 2010–11–23
  5. By: Anna Ilyina; Eugenio Cerutti; Yulia Makarova; Christian Schmieder
    Abstract: This paper presents a stylized analysis of the effects of ring-fencing (i.e., different restrictions on cross-border transfers of excess profits and/or capital between a parent bank and its subsidiaries located in different jurisdictions) on cross-border banks. Using a sample of 25 large European banking groups with subsidiaries in Central, Eastern and Southern Europe (CESE), we analyze the impact of a CESE credit shock on the capital buffers needed by the sample banking groups under different forms of ring-fencing. Our simulations show that under stricter forms of ring-fencing, sample banking groups have substantially larger needs for capital buffers at the parent and/or subsidiary level than under less strict (or in the absence of any) ring-fencing.
    Keywords: Banks , Capital , Credit risk , Cross country analysis , Eastern Europe , International banking , Regional shocks ,
    Date: 2010–11–04
  6. By: Herve Alexandre (DRM - Dauphine Recherches en Management - CNRS : UMR7088 - Université Paris Dauphine - Paris IX); Karima Bouaiss (CERMAT - Centre d'Etudes et de Recherche en MAnagement de Touraine - IAE de Tours); Catherine Refait-Alexandre (CRESE - Centre de REcherches sur les Stratégies Economiques - Université de Franche-Comté : EA)
    Abstract: The volume of credit granted in the form of syndicated loans saw a marked downturn in 2008. This article seeks to understand how certain firms were nonetheless able to benefit from larger facilities or a lower interest rate than others. Using a sample of syndicated loans issued in 2008 in North America and Europe, and records of syndicated loans since 2003, we show that firms that had developed a relationship with an investment bank obtained a lower spread, but did not benefit from greater loan facilities or longer maturities.
    Keywords: syndicated loans, banking relationship, credit rationing
    Date: 2010–09–15
  7. By: Deborah Gefang (Department of Economics, University of Lancaster); Gary Koop (Department of Economics, University of Strathclyde; The Rimini Centre for Economic Analysis (RCEA)); Simon M. Potter (Research and Statistics Group, Federal Reserve Bank of New York)
    Abstract: This paper develops a structured dynamic factor model for the spreads between London Interbank Offered Rate (LIBOR) and overnight index swap (OIS) rates for a panel of banks. Our model involves latent factors which reflect liquidity and credit risk. Our empirical results show that surges in the short term LIBOR-OIS spreads during the 2007-2009 fi…nancial crisis were largely driven by liquidity risk. However, credit risk played a more signi…cant role in the longer term (twelve-month) LIBOR-OIS spread. The liquidity risk factors are more volatile than the credit risk factor. Most of the familiar events in the fi…nancial crisis are linked more to movements in liquidity risk than credit risk.
    Date: 2010–01
  8. By: Artashes Karapetyan (Norges Bank (Central Bank of Norway)); Bogdan Stacescu (Norwegian School of Management (BI))
    Abstract: Since information asymmetries have been identified as an important source of bank profits, it may seem that the establishment of information sharing (e.g., introducing credit bureaus or public registers) will lead to lower investment in acquiring information. However, banks base their decisions on both hard and soft information, and it is only the former type of data that can be communicated credibly. We show that when hard information is shared, banks will invest more in soft information. These will produce more accurate lending decisions, provide higher welfare, lead to an increased focus on relationship banking and favor informationally opaque borrowers. We test our theory using a large sample of firm-level data from 24 countries.
    Keywords: Bank competition, information sharing, relationship bank, hard, soft
    JEL: G21 L13
    Date: 2010–11–25
  9. By: Carl Middleton
    Abstract: This paper puts forward the case for Thailand’s commercial banks to move towards more sustainable banking practices that proactively contribute towards socially and environmentally sustainable and just societies. It argues that such reforms would also benefit the banks themselves by ensuring that social and environmental investment risks are quantified and therefore minimized, whilst at the same time opening the door to previously unidentified “green†investment opportunities.
    Keywords: sustainable, commercial banks, Asian financial crisis, dams, banking, banks, Laos, Thailand, social, environmental investment, investment opportunities,
    Date: 2010
  10. By: Romain Ranciere; Aaron Tornell; Athanasios Vamvakidis
    Abstract: This paper constructs a new measure of currency mismatch in the banking sector that controls for bank lending to unhedged borrowers. This measure explicitly takes into account the indirect exchange rate risk that banks undertake when they lend to borrowers that will not be able to repay in the event of a sharp depreciation. Such systemic risk taking is not captured by indicators that are based only on banks’ balance sheet data. The new measure is constructed for 10 emerging European economies and for a broader sample that includes 19 additional emerging economies, for the period 1998 - 2008. Comparisons with previous currency mismatch measures that do not adjust for unhedged foreign currency borrowing illustrate the advantages of the new approach. In particular, the new measure flagged the indirect currency mismatch vulnerabilities that were building up in a number of emerging economies before the recent global crisis. Measuring currency mismatch more accurately can help country authorities in their efforts to address vulnerabilities at the right time, avoiding hurting growth prospects.
    Keywords: Banking sector , Cross country analysis , Currencies , Economic models , Emerging markets , Europe , External borrowing , Financial crisis , Fiscal risk , Loans , Sovereign debt , Time series ,
    Date: 2010–11–17
  11. By: Scott Davis
    Abstract: Recessions that are accompanied by financial crises tend to be more severe and are followed by slower recoveries than ordinary recessions. This paper introduces a new Keynesian model with financial frictions on both the demand and supply side of the credit markets that can explain this empirical finding. Following a shock that leads to a decline in economic activity, an adverse feedback loop arises where falling profits and asset values lead to increased defaults in the real sector, and these increased defaults lead to increased loan losses in the banking sector. Following this increase in loan losses, financial frictions in the banking sector imply that the banking sector itself may face difficulty obtaining funds. This disruption in the intermediation process leads to a further decline in output and asset prices in the real sector. In simulations of the model it is found that this feedback loop operating through the balance sheets of financial intermediaries can lead to as much as a 20 percent increase in business cycle volatility, and impulse response analysis shows that in the presence of financial frictions the path back to the steady state after a shock is much slower.
    Keywords: Business cycles - Econometric models ; Financial markets ; International finance ; Financial crises ; Recessions
    Date: 2010
  12. By: Simplice A, Asongu
    Abstract: The business of this study is to investigate what role openness play in bank efficiency with respect to income levels. From a panel of 29 countries spelling from 1987 to 2008, we provide evidence that; trade and financial openness, breed less bank efficiency in low income countries; justifying the absence of a banking comparative advantage in said countries and therefore a likely palaver of over-liquidity. Results for middle income countries are not significant. For policy implication, it holds that; openness will increase the economic cost of banks in low income sampled countries. Bearing this in mind, trade openness will be more detrimental than financial openness.
    Keywords: Bank efficiency, Openness, Panel, Africa
    JEL: F4 D6 F3
    Date: 2010–11–26
  13. By: Cesaroni, Giovanni
    Abstract: The work discusses a basic proposition in the theory of competition in markets with adverse selection (Bester, 1985). By working out the sequence of market transactions, we show that the effectiveness of collateral in avoiding equilibrium rationing depends on an assumption of uncontestability of the loan market. If contestability is restored to its proper place, the separation of borrower by means of sufficient collateral does not impede the emergence of credit rationing, which results from a coordination failure among risk-neutral banks. As a consequence, even in a risk-neutral environment with suitable endowments, the use of collateral in credit contracts could not be a socially efficient screening-device. Our conclusion on rationing does not stand in contrast with the general result of Gale (1996).
    Keywords: Adverse selection; Collateral; Rationing; Contestable markets;
    JEL: L10 D82 G21
    Date: 2010–10–11
  14. By: Bos Jaap; Lamoen Ryan van; Economidou Claire (METEOR)
    Abstract: This paper examines whether large U.S. banks have become ''too big to innovate''. We extend the theoretical work of Aghion et al. (2005b) by relaxing their assumption that unit costs are independent from output levels in order to investigate the effect of scale (dis)economies on the competition-innovation nexus. With our model we can derive conditions under which the innovation behavior of firms with scale diseconomies becomes more or less responsive to competitive changes. Our empirical results show that decreases in thelevel of competition lead to very large drops in innovation. Large banks, already operating beyond the minimum efficient scale, have indeed become ''too big to innovate''.
    Keywords: Industrial Organization;
    Date: 2010
  15. By: Elizabeth Laderman; Carolina Reid
    Abstract: Over the last three years, the financial crisis and ensuing recession have led to tectonic shifts in the availability of credit, especially for small businesses. Data show that the number of loans to small businesses has dropped from 5.2 million loans in 2007 to 1.6 million in 2009. This trend is of significant concern to policy-makers, particularly given the important role that small businesses play in the US economy. Making credit accessible to small businesses, therefore, is seen as a critical component of economic recovery. Despite this policy focus, however, few studies have documented recent trends in small business lending, and even fewer have focused attention on the implications of the reduction in credit for small businesses in low- and moderate-income neighborhoods. ; In this paper, we seek to address this gap by examining trends in small business lending in low- and moderate-income (LMI) neighborhoods by large banks regulated under the Community Reinvestment Act (CRA). We find that there is a strong relationship between the boom and bust housing market cycle and patterns in small business lending, both over time and over space. While small business lending expanded rapidly between 2003 and 2007, this expansion was uneven, and neither LMI communities nor neighborhoods with a high percentage of African American residents appear to have benefited as much as other areas from the boom. Since 2007, small business lending has contracted significantly, particularly in areas that have also seen contractions in the housing sector. Our results show significant spillover effects of the mortgage crisis into small business lending—for the economy as a whole as well as for LMI areas in particular. Our findings suggest that in order to reverse the cycle of disinvestment in neighborhoods hit hard by foreclosures, we need to address the small business sector as well as housing.
    Keywords: Bank loans ; Small business - Finance
    Date: 2010
  16. By: Kiss, Hubert Janos (Departamento de Análisis Económico (Teoría e Historia Económica). Universidad Autónoma de Madrid.)
    Abstract: This paper introduces the possibility of signaling into a finite-depositor version of the Diamond-Dybvig model. More precisely, the decision to keep the funds in the bank is assumed to be unobservable,but depositors are allowed to make it observable by signaling, at a cost. Depositors decide consecutively whether to withdraw their funds or continue holding balances in the bank, and they choose if they want to signal the latter decision. If the cost of signaling is moderate, then bank runs do not occur. Moreover,no signals are made, so the unconstrained-efficient allocation is implemented without any costs.
    Keywords: bank run; sequential game; signaling; iterated deletion of strictly dominated strategies; coordination.
    JEL: C72 D82 G21
    Date: 2010–11
  17. By: Chiara Forlati (Chair of International Finance, Ecole Polytechnique Federale de Lausanne (EPFL), Switzerland); Luisa Lambertini (Chair of International Finance, Ecole Polytechnique Federale de Lausanne (EPFL), Switzerland)
    Abstract: This paper develops a DSGE model with housing, risky mortgages and endogenous default. Housing investment is subject to idiosyncratic risk and some mortgages are defaulted in equilibrium. An unanticipated increase in the standard deviation of housing investment produces a credit crunch where delinquencies and mortgage interest rates increase, lending is curtailed, and aggregate demand for non-durable goods falls. The economy experiences a recession as a consequence of the credit crunch. The paper compares economies that differ only in the riskiness of housing investment. Economies with lower risk are characterized by lower steady-state mortgage default rates and higher loan-to-value and leverage ratios. The macroeconomic effects of an unanticipated increase in housing investment risk are amplified in high-leverage economies. Monetary policy plays an important role in the transmission of housing investment risk, as inertial interest rate rules generate deeper output contractions.
    Keywords: Housing, Mortgage default, Mortgage Risk
    JEL: E32 E44 R31
    Date: 2010–11
  18. By: Candelon Bertrand; Dumitrescu Elena-Ivona; Hurlin Christophe (METEOR)
    Abstract: This paper proposes a new statistical framework originating from the traditional credit-scoring literature, to evaluate currency crises Early Warning Systems (EWS). Based on an assessment of the predictive power of panel logit and Markov frameworks, the panel logit model is outperforming the Markov switching specitcations. Furthermore, the introduction of forward-looking variables clearly improves the forecasting properties of the EWS. This improvement confirms the adequacy of the second generation crisis models in explaining the occurrence of crises.
    Keywords: macroeconomics ;
    Date: 2010
  19. By: Giovanni Barone-Adesi (The Swiss Finance Institute, University of Lugano, Switzerland; The Rimini Centre for Economic Analysis (RCEA), Italy)
    Abstract: The persistence of financial instability calls into question the adequacy of the current regulatory regime. A critical review of the three pillars at the core of current financial regulation exposes some structural flaws. Four new pillars are proposed and compared with measures proposed to shore up the current financial architecture.
    Date: 2010–01
  20. By: Khaleque, Abdul
    Abstract: This paper uses 2973 loan profile records of 2810 poor households who have taken these loans from different quasi-formal sources of which about 50 percent of the loan taken is supplied by the Ultra-poor oriented program designed by PKSF. The objective of this program was to create some income source for these Ultra-poor through credit support. But diversion of loan use from the proposed IGA to other non-productive sector, especially to consumption hinders the objects and at the same time causes a threat to the MFIs as some of them become default. We observe that among these Ultra-poor households who have taken loan, about 68 percent of the loan was diverted from the proposed IGA to other activity with different degree of diversion and of these diverted loan, 40 percent was fully diverted. We find that among the non-savers, wage employers, inhabitants of char have higher likelihood of diverting their received loan from the proposed IGA to others and more than 28 percent of each loan on average was used for consumption.
    Keywords: Credit; Diversion; Default; Fund; IGA; Index; Loan; Microfinance
    JEL: D11 D12 R20
    Date: 2010–11–15
  21. By: Davidson, James; Meenagh, David (Cardiff Business School); Minford, Patrick (Cardiff Business School); Wickens, Michael (Cardiff Business School)
    Abstract: A Real Business Cycle model of the UK is developed to account for the behaviour of UK nonstationary macro data. The model is tested by the method of indirect inference, bootstrapping the errors to generate 95% confidence limits for a VECM representation of the data; we find the model can explain the behaviour of main variables (GDP, real exchange rate, real interest rate) but not that of detailed GDP components. We use the model to explain how `crisis' and `euphoria' are endemic in capitalist behaviour due to nonstationarity; and we draw some policy lessons.
    Keywords: Nonstationarity; Productivity; Real Business Cycle; Bootstrap; Indirect Inference; Banking Crisis; Banking Regulation
    JEL: E32 F32 F41
    Date: 2010–11
  22. By: Sergio Mayordomo; Juan Ignacio Peña Sánchez de Rivera; Eduardo S. Schwartz
    Abstract: The presence of different prices in different databases for the same securities can impair the comparability of research efforts and seriously damage the management decisions based upon such research. In this study we compare the six major sources of corporate Credit Default Swap prices: GFI, Fenics, Reuters EOD, CMA, Markit and JP Morgan, using the most liquid single name 5-year CDS of the components of the leading market indexes, iTraxx (European firms) and CDX (US firms) for the period from 2004 to 2010. We find systematic differences between the data sets implying that deviations from the common trend among prices in the different databases are not purely random but are explained by idiosyncratic factors as well as liquidity, global risk and other trading factors. The lower is the amount of transaction prices available the higher is the deviation among databases. Our results suggest that the CMA database quotes lead the price discovery process in comparison with the quotes provided by other databases. Several robustness tests confirm these results.
    Keywords: Credit Default Swap prices, Databases, Liquidity
    JEL: F33 G12 H63
    Date: 2010–11
  23. By: Zenger, Hans
    Abstract: Two widely discussed pricing benchmarks in the literature on payment cards markets are the "tourist test" interchange fee (Rochet and Tirole, 2010), which internalizes usage externalities in payment card markets, and "perfect surcharging" by merchants (Rochet and Tirole, 2002). This paper shows that these benchmarks are allocatively equivalent. Implications for the regulatory treatment of interchange fees and no-surcharge rules are discussed.
    Keywords: Interchange fees; Two-sided markets; Surcharging; Tourist test
    JEL: L42 L31 G21
    Date: 2010–11–15
  24. By: Caitlin Ann Greatrex (Iona College, Department of Economics); Erick W. Rengifo (Fordham University, Department of Economics)
    Abstract: This paper adds to the literature on the financial markets’ reaction to government interventions during the 2007-2009 financial crisis by analyzing the response of US firms’ credit default swap spreads to key government actions. We find that the government measures taken to stabilize both the financial sector and the overall economy were generally well-received by CDS market participants, reducing perceived credit risk across a broad cross-section of firms. Financial firms responded most favorably to financial sector policies and interest rate cuts, with announcement date abnormal CDS spread changes of -5 and -2 percent, respectively. Non-financial firms responded most favorably to conventional fiscal and monetary policy tools with spread reductions of approximately one percent upon announcement of these measures. In a cross-sectional regression analysis, we find that size, recent performance, profitability, and stock returns are key factors in explaining the financial sectors response to government actions.
    JEL: G14 G18 G28
    Date: 2010

This issue is ©2010 by Christian Calmès. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.